A Simple Model for the Study of Shorting Stocks

Abstract

Based on a simple quantitative model, arguments for and against the shorting of a stock are presented for the following issues: 1) short selling causes the stock’s market price to fall, 2) short selling adds liquidity to the stock, 3) short selling causes the stock’s expected return to rise, 4) short selling increases the stock’s volatility, 5) short selling should be allowed only in the derivatives market, 6) short selling reduces capital for new investments, and 7) short selling may cause a “depression trap” (i.e., where the stock’s market price is stuck at an extremely depressed level, despite a more than adequate number of reasonable bids).

TOPICS: Quantitative methods, volatility measures, risk management